Making use of gift exemptions for IHT

According to a recent survey undertaken on behalf of HMRC, only 25% of people making financial gifts have a working knowledge of inheritance tax (IHT) rules surrounding such payments.

The report entitled Lifetime Gifting: Reliefs, Exemptions, and Behaviours, reveals a significant lack of awareness of the gifting rules, liability for inheritance tax and the risk of making financial gifts without considering tax rules, which can apply for any gifts over £3,000 in value in a given tax year.

The research also revealed that those with potentially smaller estates (below £500,000) appear to have a limited knowledge of the longer-term reach of inheritance tax, the seven-year rule or annual limit on gifts.

Gifts

The IHT annual exemption enables a person to give away up to £3,000 per annum free of IHT. In addition, any unused exemptions from the previous year, may be carried forward, although any unused exemptions earlier than a year will be lost. This means that if no gifts have been made in the previous tax year, a person could make an IHT-free gift in the current tax year of £6,000. If the amount exceeded the annual exemption available, it could still remain exempt from IHT, if the person making the gift survives seven years.

If the person making the gift dies within this seven year period, the gift may be taxed on a sliding scale known as 'taper relief'. This means that where the gift was given less than three years before death, tax on the gift is charged at the full rate at 40%, reducing to a taxable rate of 8% if the gift is given six to seven years before death.

With many families facing expensive care costs for family members, it is important to note that there are strict rules on property transactions. While a gift given more than seven years before death is not normally counted towards the value of the estate, this is not true where a gift is subject to a reservation of benefit. This means, for example, if an individual gives away their home to their children and continues to occupy it rent-free, the property is treated as forming part of the individual's estate immediately before their death for IHT purposes.

In addition to the annual exemption, small gifts of up to £250 per year may be made free from IHT. The gift must be an outright gift to any one person each tax year.

Gifts on marriage can also be free of IHT provided that the gift does not exceed set limits. The limits depend on the relationship to the married couple/ civil partners and are as follows:

These exemptions may be combined in certain circumstances to reduce a potentially exempt transfer (PET).

IHT threshold

The current starting threshold for IHT for a single person is £325,000, and £650,000 for married couples and civil partners, who have the added benefit of the residential nil-rate band giving them an additional £150,000 each of tax-free property-based inheritance as of 6 April 2019. The allowance is set to rise to £175,000 from 6 April 2020.

This additional tax relief is only available when assets are passed on to direct descendants, including children or grandchildren, tax-free after their death. The rules governing the inheritance tax (IHT) nil rate band are complex and will need careful consideration.

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